Message from the CFO
1. Initiatives for improving investment efficiency and lowering capital costs
Improving investment efficiency
At Mitsui Chemicals, we make use of portfolio management, KPI management, and the optimization of investment evaluations to improve investment efficiency.
As part of portfolio management, we assess all our businesses based on ROIC*and profit growth rate and identify issues in each business. If ROIC is lower than the WACC in a particular business, we implement measures aimed at transforming its portfolio, for example, by formulating a remodeling strategy in the three-year rolling plan we execute annually to discuss among management.
In KPI management, we break down ROIC into indicators that can be managed at the business division level; they include profit-and-loss statement-related metrics such as net sales and operating income, as well as balance sheet metrics like the cash conversion cycle. We will then expedite the actions required for improvement by monitoring each indicator. We intend to deepen our KPI management activities up ahead by more closely linking each indicator to employee evaluations.
As for initiatives to optimize our investment evaluations, IRR is the main criterion on which we base our investment decision-making. We evaluate investment projects with reference to our hurdle rate, which is based on capital costs and takes into account risk factors. We also make efforts to improve our investment evaluation process by annually reviewing past projects and analyzing the factors why the results of some investments diverged considerably from plan. We are currently examining a number of investments centering on production capacity expansion for products whose demand is expected to rise up ahead. We intend to carefully select projects for investment by first making fully sure of their economic viability.
*ROIC: Return on invested capital
Lowering capital costs
In aiming to lower capital costs, we are working to lower earnings volatility, achieve an optimal capital structure, and strengthen communication with investors.
First of all, let me please go through our initiative for lowering earnings volatility. In the past, we experienced a slump in Company-wide earnings when those products such as phenol, purified terephthalic acid, and polyurethane materials sank deep into the red. At the time, these products commanded a high export ratio to China and other Asian markets, but margins on exports deteriorated sharply when supply-demand conditions worsened as Chinese manufacturers expanded or built new plants. In response, we made the decision to embark on structural reforms accompanying large extraordinary losses in fiscal 2013. Since then, we have retired our production facilities, which included the closure of production sites, based on the principle of local production for local consumption. Accordingly, we have been successful in downgrading the size of our production capacity to meet domestic demand. As a result, the ratio of local production for local consumption for the aforementioned three products now stands at 80%. At the same time, we have introduced a formula method to link product prices to raw material costs in an effort to minimize the impact from fluctuations in market prices. The price formula ratio for our mainstay products in the Basic Materials domain has now improved to 70%. These initiatives have been the catalyst behind our successful switch to a stable earnings structure even for the Basic Materials domain, which includes products generally regarded as being susceptible to earnings volatility. Going forward, we will look to further stabilize earnings by reinforcing the competitiveness of crackers and other products.
We are pursuing an optimal capital structure through which we can balance financial soundness and minimizing capital costs. Owing to the aforementioned slump in Company-wide earnings, the net D/E ratio at one time deteriorated as far as 1.44, but thanks to the benefits of subsequent structural reforms, it has now improved to around the 0.70 level. Our credit rating has also been upgraded from A to A+ by Japan Credit Rating Agency, Ltd. (JCR) and from A– to A by Rating and Investment Information, Inc. (R&I). While we expect to see an increase in interest-bearing debt as we step up the pace of investments, we will endeavor to keep the net D/E ratio and our credit ratings at current levels and find the right balance between financial soundness and minimizing capital costs.
In order to strengthen communication with investors, we have continuously engaged in dialogue to ensure they have a solid understanding of our Company’s management circumstances, including the aforementioned initiatives implemented thus far. Many of the investors we have met with in person have mentioned that they gained a good understanding about our earnings stability and future growth prospect. Meanwhile, in terms of the broader stock market’s perception, I get the feeling that market participants have yet to erase the image that our earnings are highly volatile. For this reason, we will continue to provide more opportunities to engage in dialogue.
2. Investment plan
Over a three-year period from 2014 to 2016, we took steps to improve the Company’s financial structure. As a result, the net D/E ratio has improved to around 0.70 as already mentioned, but at the same time, cutting back on investments has limited our capacity to expand sales of mainstay products. That is why our 2025 Long-Term Business Plan formulated in fiscal 2016 calls for growth investments to the tune of ¥1 trillion over a 10-year period. Roughly 90% of this figure will be spent on our three targeted business domains and we plan to allocate ¥600 billion to capital expenditure aimed at expanding production capacity and strengthening competitiveness, while ¥400 billion will fund M&As and other strategic investments. That said, our basic approach to investment is that the amount we have earmarked is not our only concern. We will continue to carefully select projects with a strong likelihood of ample returns on investment.
Also, with the aim of achieving the objectives set out in the 2025 Long-Term Business Plan, every year we put in motion a strategic and numerical three-year rolling plan. For 2019–2021 we have earmarked ¥430 billion for investments and 75% of this, or just over ¥300 billion, will be allocated to investments for growth and streamlining, while the remaining ¥100 billion or so will be directed towards maintenance investments, including facility upkeep. The investments for growth and streamlining will center on new installation or upgrading of facilities in the three targeted business domains because of the many products that require greater production capacity to meet growing demand, particularly in the Mobility domain. We will also invest in the Basic Materials domain with the aim of strengthening our competitive edge mainly by diversifying the raw materials for our cracker and installing new gas turbines for utility plants. Even though funds for M&A are not included in the figure mentioned above, in the event that we do consider an M&A deal, we will scrutinize the Company’s financial standing and strategic compatibility.
Cash flows and net D/E ratio
3. Management targets
Our 2025 Long-Term Business Plan sets out the following numerical targets: net sales of ¥2 trillion, operating income of ¥200 billion, ROE of 10% or more, and a net D/E ratio no higher than 0.8. We also recently set a new ROIC target of 8% or higher. We intend to ramp up the pace of our initiatives going forward with the aim of achieving these targets.
Our three-year rolling plan for 2019–2021 calls for operating income of ¥140 billion and net income of ¥100 billion in 2021. Restricting our investments caused earnings to plateau over the last few years, but we think benefits from various investment projects will begin to materialize from around 2021 and beyond.
We also recently disclosed ROIC for each of our business segments to serve as a yardstick to quantitatively measure the transformation of our business portfolio. We forecast an improvement in Company-wide ROIC from 6.0% in 2018 to 7.5% by 2021. By business segment, ROIC for the Mobility segment currently hovers at a high level. Invested capital will increase up ahead as we expand our capital expenditure, but we aim to keep ROIC at a high level, buoyed by profit growth. In the Health Care segment, invested capital will increase to a certain extent, but we anticipate an improvement in ROIC on the back of profit growth driven by greater sales of vision care materials and an earnings recovery in nonwoven fabrics and dental materials, both of which remained sluggish in 2018. In the Food & Packaging segment, we aim to improve ROIC by expanding sales of agrochemicals, turning around sales of ICROS™ Tape, which were tempered by a slowing semiconductor market from the second half of 2018, and bringing the new Taiwan plant on stream. In the Basic Materials segment, even though invested capital is going to rise due to higher capital expenditure, we forecast an improvement in ROIC along with increased profitability mainly from stronger competitiveness.
Operating income and net income
4. Shareholder returns
While our top priority is the enhancement of corporate value through business growth and expansion, we also see the return of profits to our shareholders as a key management priority. Our policy on shareholder returns is to continuously increase dividends in line with performance trends and aim to achieve a total return ratio of 30% or more by flexibly acquiring treasury stock depending on the share price and market conditions.
*On October 1, 2017, Mitsui Chemicals conducted a 5-to-1 share consolidation. All dividends are re-calculated based on this share consolidation.